What is the difference between Non-deliverable Forward and Forward?

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Its a bit confusing. Here are the key points:

  1. In simple Forward, underlying notional currencies are exchanged. Where as in Non-deliverable Forward (NDF), there is no exchange of notional amount.
  2. In NDF, upon maturity, the difference between NDF rate and prevailing spot rate is the settlement amount.
    • This settlement could be in any third currency as initially agreed.
    • In case NDF, you may never have to own or deal with underlying currencies as settlement can be in totally different currency.

Simple Example:

For instance, you are in New York, you want to hedge or bet a exchange rate between Indian Rupee and Italian Lira. These currencies may not be trading in New York or you may not own them or they may be restricted by US. You can simply buy NDF from someone in New York with settlement currency being USD. On maturity, you will calculate change in NDF and prevailing spot of INR/ITL and then convert to USD to settle in USD.

Hope this is simple enough.

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